Own a buy-to-let? The way you are taxed is changing.
Posted on 9th August 2016
Buy-to-let owners will suffer additional tax over the next few years as new rules are being phased in relating to how much tax relief you get for mortgage interest. Read on to see what the changes are and how it may affect you.
From April 2017, the amount of mortgage interest tax relief buy-to-let owners can claim is being restricted. This will have an impact on the amount of tax they pay – and it is not good news!
How is buy-to-let income taxed?
Buy-to-let owners must declare the income they receive in rent on their personal (self-assessment) tax return each year.
As a reminder, the personal tax year ends on 5 April and you have until the following 31 January to submit your return and pay any tax due.
If you are not already registered for self-assessment but start receiving rental income, you must register for self-assessment.
What is mortgage interest tax relief?
Traditionally, landlords could deduct all their mortgage interest from the rental income they received to calculate the profit or taxable income.
This meant that the landlord was effectively getting relief from paying tax on the mortgage interest amount. This is known as mortgage interest tax relief.
How is the tax currently calculated (pre April 2017)?
Pre April 2017, landlords only pay tax on the profit made on the rent after deducting all of their mortgage interest.
As an example, this would be calculated as follows:-
|
Rental Income |
£8,340 |
|
Less: Mortgage Interest |
£7,200 |
|
Less: Any other associated costs i.e. letting agent fees, maintenance costs etc |
£834 |
|
Profit / Taxable Income |
£306 |
So, the landlord only pays tax on £306.
The tax payable will be calculated at either the basic rate (20% or higher rate (40%) depending on the landlords other income.
What is changing?
From April 2017 HMRC will restrict how much mortgage interest tax relief landlords can claim.
Landlords will only be able to deduct a restricted percentage of mortgage interest from their rental income to calculate their profit or taxable income. The remainder of the mortgage interest will be used to calculate a basic rate tax reduction.
This will be phased in over the next four years as follows:-
|
Tax Year |
Percentage of mortgage interest costs deductible from rental income |
Percentage of basic rate tax reduction |
|---|---|---|
|
Pre-Changes |
|
|
|
2016/17 |
100% |
N/A |
|
Post-Changes |
|
|
|
2017/18 |
75% |
25% |
|
2018/19 |
50% |
50% |
|
2019/20 |
25% |
75% |
|
2020/21 |
0% |
100% |
How will the tax be calculated (post April 2017)?
Post April 2017, landlords can only deduct a restricted amount of mortgage interest from their rental income to calculate their profit or taxable income. The remainder of the mortgage interest will be used to calculate basic rate tax reduction.
Using the same example as before, this is the effect:-
|
|
2016/17 |
2017/18 |
2018/19 |
2019/20 |
2020/21 |
|
Rental Income |
£8,340 |
£8,340 |
£8,340 |
£8,340 |
£8,340 |
|
Less: Mortgage Interest |
£7,200 |
£5,400 |
£3,600 |
£1,800 |
£NIL |
|
Less: Any other associated costs i.e. letting agent fees, maintenance costs etc |
£834 |
£834 |
£834 |
£834 |
£834 |
|
Profit / Taxable Income |
£306 |
£2,106 |
£3,906 |
£5,706 |
£7,506 |
|
Balance of Mortgage Interest for Basic Rate Tax Reduction |
N/A |
£1,800 |
£3,600 |
£5,400 |
£7,200 |
|
Tax Liability (if basic rate tax payer) |
£61.20 |
£61.20 |
£61.20 |
£61.20 |
£61.20 |
|
Tax Liability (if higher rate tax payer) |
£122.40 |
£482.40 |
£842.40 |
£1,202.40 |
£1,562.40 |
As you can see, this change has a clearly substantial effect on higher rate tax payers - however, basic rate tax payers should bear in mind that the change may push them into the higher rate threshold.
Tax is complicated! Get in touch to discuss these changes in more detail and to find out how much it may impact you.
Written by:
Nicola J Sorrell -
Effective Accounting
Founder | Xero Champion | IR35 Expert
Tagged as: For - Property Owners & Landlords
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